get rid of the debt ceiling law. we need some form of budget rule to make sure that some discipline going toward. >> structure. >> yes, structure. we need to show people that we will stick to this plan. >> thank you. >> thank you very much for being here. i appreciate your testimony. dr. hassett, dr. zandi has indicated that he inks the debt limit crisis we had in august 2011 was bad for the economy and the country and that we should avoid it for the future. do you agree with that? >> first, yes. i think the best testament of this has been done by co-

authors who have a very cool index of economic uncertainty. it is a very innovative paper. they estimated that the debt limit struggle probably subtracted about 1.5% from gdp growth during that summer when it was happening egos of the uncertainty and inactivity that was caused by levels of uncertainty. each time we go through that, there are consequences. i would like to add if that is what it takes to get spending under control, we need to concede that in the long run there will be a benefit, which means we do not have these deficits. in the fullness of time, whether a struggle last summer was worth it, if we have the spending cuts and deficits are lower, it might have higher economic growth in the long run because we went to that struggle

last year. >> your position is that we should be ready to go through that struggle again and to call upon the national debt is necessary in order to enforce spending limits? >> that, of course, is not my position. we should never default on the national debt. the politics of debt reduction, which you on the better than me, are very difficult. i am not a political expert. if there is something we need to do that helps deficit reduction occur, i am not willing to stop process. >> you are saying defaulting of

the national debt might be something we need to do now and then? >> no, sir. we do not default last summer. >> we did not. but we might in january of february. is it your position that we should be willing to default on the debt if that is necessary in order to force spending cuts? >> i would not be willing to default on the debt under any circumstances. look at the history of what has been done. there is a long history of using that debt limit as a moment to distract from the party in power. if we had an academic seminar on the impact of the that struggle and the fiscal policy, he would say that it was a negative thing. >> well, i have never until last year of august 2011, i have not seen any serious effort or serious threat made by the leadership of congress to refuse to give the secretary of treasury the ability to offer to meet obligations congress

had adopted. i thought that was a new experience for us. it certainly was for me to see that happen. dr. zandi, you said you think that we need to repeal this law that tries to set a debt limit and concentrate more on taxing and spending policies that causes to raise the debt, as i understand? >> absolutely. it is a bad way to conduct policy. it is a problem. look at july and august of 2011. it was a mess. gdp downgraded the debt. it really had an impact.

cbo is estimating the interest costs is costing us money. it is pretty clear that this is not going to get any better going forward. it will be worse. this is a really bad way of doing things. we need to get rid of this. having said that, we need budget rules. we need to find a way to be credible. the debt ceiling approach is the wrong way of doing it. >> thank you, mr. chairman. >> thank you, senator. >> i want to pursue that question a little bit. this is on my mind also. my experience is the political system find it awfully difficult to say no to constituents. with reelection in mind or a natural human tendency to want

to please people rather than disappoint them. i had the privilege of meeting with christine lagarde from the imf. i asked about the reforms that were taking place in europe. i asked, would any of these reforms be taking place without europe being in a fiscal crisis mode? her answer was, absolutely not. unless the revolver is at the temple of the politicians with the finger on the trigger, they're not capable of summoning the collective will to tell the people that represent that they need to take steps to resolve a problem and will cause disappointment and pain to do so. my experience in the years i

have had in politics was exactly that. we never would have gotten what we did in 2011 without the threat of defaulting on our debt. to think that we could put a structure in place today that perhaps we would all be comfortable with in terms of solving our long-term problems and be assured that 10 years or not that congress would not have modified that dozens of times to the response of into joints who are banging on the door and saying this is to develop much pain, we could hardly sustain a policy for months around here, let alone 10 years. if you want to fix the long-term

situation, i think there is consensus that we cannot get from here to here to provide that kind of growth and what we want to hand off to future generations. we have to factor in a big factor of the political system here in the way politicians think and react. we need leverages in order to address that. i'm not really asking for a response. you have already answered to that. you have stated your position. i just wanted to add my two cents worth in terms of why i think it is important we have the leverage points. maybe there are other ways of doing this, but my experience is that the next congress or the current congress can undo that in a big hurry as the constituents line up outside their doors. thank you, mr. chairman. >> can i -- in response? >> yes.

>> in the case of putting the revolver against the -- in the case of europe, we do not want to do this on a regular basis. that'll be a problem for our economy. people will not be engaged unless they have clarity in this thing. i have more faith in this institution. after the end of the day, you do the right thing. if you look at the history of this body, it roughly comes up with the right answer. we have not dealt with the debt ceiling since the beginning of this country. i think we are very capable and we can do it. >> i will respond by saying

that we have been trying to deal with our cascading debt and deficit for decades. i would say that we have been far short of doing the right thing to look for a healthy fiscal future. >> thank you, senator. >> i agree that we usually do the right thing but only after we try everything else. the time has come. i see this as a scary time. we need to protect our fragile economy, but it is also an opportunity to move forward. my first question is based on your predictions -- what do you think the timeframe is for possible further downgrades from the credit rating agencies?

>> this is my interpretation. i do not know for sure, but this is a guess from my experience. i think people outside of the beltway have a lot more faith in you than you do. there will not be a negative reaction. by the way, i would counsel -- you will get a better deal. >> in other words, a deal that does not mean much would not help us? >> in order to avoid a downgrade in the u.s. treasury debt, we need something lows to fiscal sustainability.

we need to get to $3 trillion. if we fall short of that, that is a problem. >> ok. you brought up social security. to't we need more reforms make that more solvent? if we were to embark on that and set up a commission, i think there is a lot of talk of ok, we should do that. >> i think that is a perfectly reasonable way to do it. >> my colleagues said that in the near term he would rather see rates go up on the wealthiest americans because he believes it gives us a greater long-term chance to reform the

tax code. do you agree with this assessment? also, do you think this is awise course? i support going back to the clinton levels. do you agree? we should look at raising taxes on the wealthiest rather than just -- >> i think we need to do both. if you are going down my path, we need both. there is no way to get to that number with tax reform alone. if you consider we will not take away a charitable deduction and if your goal is not to raise taxes from lower and middle-income houses. there is no way to do the arithmetic.

there is no good way of doing it to raise that kind of revenue. we need to do both. we need tax reform and we need higher tax rates on upper- income households. >> it seems to me you could do the tax rates at the end of the year because then you could make the kind of deal that you want. to some of the closing of the loopholes. you could bring the corporate tax rate down and work on the debt by closing the loopholes and subsidies. >> tax reform is complicated. nail down a framework and then go to work and try to figure this out. in terms of corporate tax reform, that is absolutely necessary. the goal would be to make that revenue neutral. you want to bring down those

corporate rates. >> what did you think of senator coburn's assessment? >> i have a great deal of respect for the senator, but this, i disagree. it would accomplished very little in terms of economic efficiency. with unemployment still high and -- we need to seek ways to make ourselves a friendly place. i am very concerned that i have seen the president continues to say that 97% of small businesses would not be affected. it is a very misleading statistic. anyone who has any profit from a sale on ebay would have -- we would be calling them a small business.

more than half of the income is in that bracket. i strongly disagree. >> they're willing to make some sacrifices as long as we really are on the right path. they see that as their own long- term liability. thank you to both of you. >> thank you to my colleagues from pennsylvania. i would like ask dr. hassett -- the president's proposal had some specifics. i think it is clear there is a headline tax increase that he wants $1.60 trillion. what the administration would describe is $600 billion in spending reduction. it looks like 200 billion of

what they put under the 600 billion is revenue. fees and various other forms of revenue. that is not spending restraint at all. there is a deferral of the sequestration. i am not clear how long that referral is meant to be. for one year, that is $100 billion. then there is additional stimulus spending and other things that add up to about $100 billion. that is $400 billion in the way. you should legitimately deduct from the headlines 600 billion if he wanted to write what might be legitimate spending restraint. if you go back, $1.60 trillion of new revenue, maybe we have

$200 billion in spending restraint, it is it fair to say that this is a 8 to 1 ratio? >> that is about right. >> eight times the spending restraint. >> that is right. there is some recidivism here in the sense that spending reductions have systematically been overstated in recent years by the president. it appears to me that there is a lot of tax increase and almost no spending reductions. >> spending programs that you launch, that money gets spent. promises of future savings? much less so. when the president talks about new stimulus spending, i am not sure the savings would materialize at all.

in reality, the president's proposal is almost entirely of new taxes and virtually nothing that is specific of the spending restraint. your research suggests that the most successful point of consolidation are those in which the ratio is almost the reciprocal of that. >> i can say with absolute certainty that a consolidation that has the shape of the president's proposal would fail. in the economy that we have now, in that kind of a world, it is impossible to envision generating the kind of healthy economic growth that the government is willing to have the spending cuts we promise to do two years from now. we will be saying, we cannot afford to cut government spending because it will throw

us into recession. >> that brings me to the next issue i would like to discuss. to get to the president's tax increase package that he is looking for, he is calling for higher marginal tax rates. in addition, a reduction in the value of deductions and other expenditures. higher taxes on capital gains, dividends. the way i count this up, if you include the limitations, the top marginal tax rates for some would be between 41 and 45%. that is just the federal level. we have states with varying income tax rates. some americans would be paying more than half of their income. it would exceed 50%. if the president got all the tax increases that he wants, is

likely that could precipitate a recession? >> it is not only likely, it would certainly do so. it is cataclysmic. if we go from a 15% dividend tax, to 45%, that is ridiculously bad news for an equity markets. it is something we saw on the other side. call for response to the dividend tax reductions and there was a lot of positive movement. as a package, there is a question of how negotiations work and maybe you want to start negotiations with an extreme position, i cannot imagine anybody looking at proposal and not arguing that it would not throw us into recession.

>> rather than taking an extreme that is very harmful, you look for areas where the other side to meet halfway. for instance, because of the political imperative that has been created, if revenue has to be part of this, shouldn't at least be generated in the way it does the least economic harm? in your view, would you do less economic damage by generating revenue through reducing the value of expenditures than raising marginal rates? >> if you phase it in far in advance, for example, changing social security benefits when i retire now, he would have a positive growth the fed right now from the spending cuts because she would give clarity to all the people worried about the future of america. >> my time has expired. >> good morning.

health care inflation is a significant driver of medicare escalating before us, what do you think should be done to control that inflation? i heard what you said about medicare. that is -- no matter what you do, you still have this inflation going on. it is major. >> let me say a few things. health care inflation in the last couple of years has slowed quite sharply. it has been about 3.5%. it is very positive developments.

some of that probably is due to the weak economy, which means less demand for services. some of its likely is do to the affordable care act. there is growing evidence of that. we do not know for sure. there are some positive experiences in the affordable care act that could reap benefits. the insurance exchanges, the independent payment advisory board. we will have to see how that works out. most encouraged about the cadillac tax. this is a tax on gold-plated

health insurance policies for folks like me. i get a very good health care package. if i get sick, i am unfettered in terms of my health-care consumption. it will make it more costly and i will start shopping for health care. that will create more transparency and get the growth in health-care costs down. we do not know what is going to work, but there are some interesting new programs that have potential. we should see how those worked out before we engage in some very significant structural changes. like a voucher program. we may have to go down that path, but it is much too premature to do that. we should see how these developments work. >> following up, "if temporarily going over the cliff is necessary to achieving a good agreement, lawmakers should not hesitate to do so."

how long do think we could stay over the cliff without doing significant damage to the economy? >> i think you could go into early february. by early february, it looks like you are not coming to a deal and investors began to discount the likelihood you're not coming to a deal, you will see stock prices decline, the bond market reacted. by mid-february, it would be doing a lot of damage. by the end of february, the debt ceiling, of really bad things will happen. you have about a month. a lot does depend on whether the treasury is permitted to freeze withholding schedules. i'm going under the assumption that they can and will do that. >> a bad deal -- no deal is

better than a bad deal. going back to, i am curious about, given your findings, do you believe the tax cuts for the first $250,000 in income should be extended immediately? is there any reason that it should be tied to tax cuts for the wealthiest in our nation? >> i think there should be done as a package. i think it will create brinkmanship. the nailing down the tax code, nailing down the spending cuts, nailing down long-term sustainability, you have to do this all once.

that is the only deal that works. >> you think that you can be done by the end of the year? >> no, i am skeptical. i think it can be done before significant damage. i am playing a political observer, but my guess is that we will have to go into next year. >> vice chairman brady. >> chairman, i apologize for being late. thank you for your leadership. you have been a terrific leader, a tremendous to work with. i appreciate your approach and how you handle yourself. thank you very much. i think there is a bit of consensus in the sense that it is irresponsible to voluntarily go off the cliff, but equally irresponsible to come to a solution that does not address the key issues facing us. spending discipline, of fixing

a broken tax code, and dealing with our biggest challenges. economic growth works. average recovery in this recession might have cut the deficit to $430 billion. returning to the pre-2008 levels. what is missing today, we know consumer spending is above what it was before the recession. government spending is above what it was before the recession. business investment, that area is what continues to lag. in your view, do you think raising taxes on the two

marginal rates as well as capital gains dividends, does that encourage more business investment in the economy? >> the threat of those increases is a very big negative. mr. brady, one of the things economists use when they teach graduate classes is something called the handbook of public economics. you had to study that, too, mark. i know i did. one of the later editions, there is a chapter on how taxes effect business spending. we go into a very gory detail about how negative this can be. if the dividend tax is going to go up, a lot of firms would be hurt significantly by that. they would be paring back their capital spending in anticipation of higher taxes in

the future. businesses will look to the future when they decide what they're going to do. they are not investing. you see it's in the investment data. it is why this recovery has been so slow. businesses have a lot of cash and are not making a lot of investment. >> your point is this does not help the economy. >> you could go back to the writings, he was a scholar who identified very early on that business cycles, recessions, and recoveries tend to be driven by investment because consumers are pretty steady, but investments can be fluctuating. his view of the problem of stabilization policy was to try to stabilize investment and not to focus on consumption.

one reason we have had such a disappointing recovery is that we have not address the fundamental reason why investment is so weak. we are a really unattractive place for investors to invest right now. >> why don't you just accept a higher tax rates? it would be politically very convenient. it does not solve the economy. it does not solve the deficit. it is not a serious deficit proposal. the credit rating agencies are looking for a plan that lowers the gdp to debt ratio. i do not think there is a magic number. social security, medicare, to find a sustainable path for word on them.

do you think the president's plan adequately addresses the sustainability of medicare and social security? >> i think he needs to go further. i do not think it is enough. i believe the proposals are good ones. i think they are hard proposals to make because they're substantive. to achieve fiscal sustainability in the context of $3 trillion in 10-year deficit reduction, i think we need to do more. >> looking at the republican plan and the president's proposal, do you see any common ground? >> the common ground is that we're looking at the same proposals. cbo has scored a number of

different approaches. i also think there is no general agreement in the context of the current discussion, we will not make any major structural changes to these programs. we will not block grant medicaid, and we will not voucher or premium support medicare. in this context, it becomes dollars and cents. this is not going to be easy. i would suggest that in this quest for more reform to medicare and medicaid, if we can say by the 10th year of the budget horizon that we are on the right path, i think that is ok. entitlement reform -- >> the number is whether we have solved the problem.

>> entitlement reform is tough and you cannot do it in 10 years. this is a long-term problem. we should be thinking about this in a 20 or 30-year horizon. cbo scoring makes it incredibly difficult. we don't want it to force us to make -- >> i would like to take a step back and step in a slightly different direction from the fiscal cliff and talk more about long-term and medium-term economic realities we face. in your written testimony to this committee, you warned against kicking the can down the road indefinitely because of the adverse effect that might have on the economy.

the medium and long-term impact it might have. i thought your analysis was definitely something we need to pay attention to. as you observed in the failure to make progress in this area now could signal that we have bigger troubles ahead. the moody's analytics model that you used breaks down about 2028. the reason it does that because at that point, the interest on our national debt will start to cripple our economy. we will be left without much recourse. i'm not sure there is a tax increase on the planet that could suddenly fix that. i'm not sure we could print money fast enough.

if we did, we would go the way of argentina. i tend to think of this medium and long term risk as the fiscal avalanche. the cliff is something we are approaching now and we can see where it is. we know will hit the cliff. the avalanche is different. the only thing you know about avalanches, you know when the conditions are present. you know when the snowpack has built up to the point where it could happen. you do not know when it is going to happen, you just know it is coming. once it hits you, the avalanche becomes completely impossible to control. do you agree with this characterization about the avalanche? could you elaborate about that kind of threat? >> would you mind if i steal that from you? i will give you credit.

i think it is right. i do think -- that is why what you're doing now is so important. this is a once in a generation opportunity for you to nail these things down. we're not that far apart. i really do not think we are. if you are able to put us on a credible path to fiscal sustainability, do it in a balanced way, i think we are golden. i think we will avoid that avalanche. if we do not do that, ultimately, it means we will never do it until we're forced by that avalanche. >> how soon will we need to do that in order to avoid the conditions? >> i do not know the answer to that. my model breaks down. it will happen long before that.

>> it could happen within the next four or five or six years. >> here is the thing. the problem is, if we do not address this, we will be stuck in this slow growth netherworld of going forward. we will get nailed by something. i do not know what it is, but something bad is going to happen. that is going to be the thing that sets off an avalanche. >> a credit downgrade? >> something we are not even contemplating. we do not know what that will be, but it will happen. we will set ourselves up for that avalanche. that is why it is so important

to get this right. >> what about a credit downgrade? if that were to happen, doesn't that call into question all kinds of things? money market funds and other types of investment funds are chartered to invest only in a certain grade of funds. if all the sudden u.s. treasuries were downgraded, wouldn't that have a pretty significant the fact on where we are relative to the avalanche? >> if there is downgraded treasury debt, this would likely trigger other downgrades. bank debt, they will get downgraded. jpmorgans of the world. money managers have in their relationship with their clients agreements not to invest in bonds that have rates below a certain grade.

they will have to divest themselves because of the downgrades. this will cause problems in the credit markets. the credit markets will ultimately adjust. the reality has not changed. you will see hedge funds and private equity firms, but that is the process. it will take time. between now and then, it will create a greater amount of turmoil. it is what this means. it means that we do not have the political will to nail this thing down. and we will not. people will recognize that and we will go nowhere. >> if you want to preserve the entitlement, get us to balance.

>> get us to sustainability. >> thank you, mr. chairman. >> i have one more question. i know we could be here a while if we had the time. i am grateful for the patience of witnesses. i was looking at the testimony and on page 8, he walks through the question of this balance of how you do the balance between cuts and revenue. in the second full paragraph, he says, using a range of different methodologies, the average unsuccessful fiscal consolidation relied upon a 53% tax increase, 47% spending cut spurred a successful consolidation consists of 85% spending cuts. i want to get your sense of that.

whether you agree with that 85- 15. if not, why not? what would your approach be? >> i respect kevin's work a lot. i think that number varies considerably depending on the country and it depends on where the economy is in the business cycle. it also depends what the reserve is with respect to monetary policy. it is one thing if interest rates are 4 or 5%. it is another thing if we are at 0. there has been a lot of really good work revolving around these issues and trying to get good benchmarks for fiscal consolidation. a really great paper came out of the imf the last couple of days on this issue. it makes a very strong case that there was a fiscal speed limit. you cannot have too much fiscal consolidation too quickly. it becomes counterproductive. this balance between tax and

spending in the context of the u.s., particularly when the economy is weak, the spending multipliers, when you cut spending, they are very large, much larger them was previously thought. i did not buy into kevin's 85- 15. in the context of where we are today, that is not right. having said that, i would do something like that proposed. two-one kind of ratio. if you do that, that is balanced and it did system reasonably good place. it gets us to fiscal stability and avoiding the avalanche. it is still more spending than tax, but it is more balanced. the last thing i would say, we're talking about taxes and spending, this is an important point.

tax reform is spending cuts. there is no difference. if i give you a mortgage interest deduction or cut you a check. no difference. from an economic perspective, they are one in the same thing. that is a spending cut. >> i do not have anymore questions. >> looking at our global competitors who find themselves in financial crisis showed more than 20 times in nine different countries, those countries cut what they owed in their spending and grew the economy at the same time. they did that because their cuts were large, credible,

politically difficult to reverse. there were real and they were believable. it created the confidence to grow an economy. it was proven over and over again. that is the model for this fiscal cliff discussion, making both the cuts and the reforms that are real and credible and politically difficult to reverse. that is the only signal we can send. it is the right signal to send to investors that we're serious about getting our financial house in order. chairman, thank you. this is your last committee meeting and you will be missed. >> going back to the analogy of the avalanche, when we had the subprime crisis, and there was no warning. likewise, we did have the same type of avalanche come tomorrow. there is no more confidence,

nobody buys are debt. we would have increased interest rates and huge economic problem. we have two things in front of us. not only the fiscal slope, but also the debt ceiling. treasury estimates at the end -- we have until the end of february. in solving it, would be better to put the debt ceiling in the package with the fiscal slope for a comprehensive solution? or would it be better to do them separately? >> they should be done together. this will not work if we break this thing apart. we need to scale back the cliff.

we need to raise or eliminate the debt ceiling. we need to achieve fiscal sustainability. this needs to be a package. >> i agree. >> i want to thank both of you for your testimony. >> thank you very much. i appreciate your good work and your leadership. thank you for your testimony. i think we made in 90-minute meeting. that is pretty close. that is pretty good. i want to thank both of our witnesses again for their testimony. by the way, without objection, the full text of your opening statements will be in the record of this hearing. we're grateful because it is clear to most americans we do have a substantial challenge with regard to the cliff. we know if we do not take the

right steps, it could jeopardize our economic recovery. we cannot afford to lose ground on the gains we have made. i am confident we can get this done. the congress of the united states can successfully reached the compromise we need to assign a path to fiscal stability. this is my last hearing. vice chairman brady mentioned it. i have enjoyed this work as chairman and as a member of the committee the last six years. i am looking forward to more work on this committee as well. our work on job creation, deficit reduction, manufacturing issues and other issues has been informed by the perspective of many of our nation's top economists. two of them are with us today. and from other leaders in the business community and the non-

profit sector. we're grateful for those insights as we seek to get answers. i also have a great working relationship with vice chairman brady. i am grateful for his work and the work of both parties on this committee. i would also like to recognize three retiring members. senator bingaman has served on the committee continuously from 1987 forward, 25 years of service. congressman from new york served from 1996-1998 and from 2005 until the present. they will all be retiring from congress at the end of the year. the record will remain open for five business days for any member of the committee who wishes to submit a statement or additional questions. if there is nothing further, we are adjourned.

thank you. [captioning performed by national captioning institute] [captions copyright national cable satellite corp. 2012] >> explores albany this weekend on c-span 2.

up next, shaun donovan discusses the finances of the federal housing administration. then the national security strategy. a pentagon briefing with the head of the u.s. pacific command. >> tomorrow morning, the national internal hosts a discussion on the u.s. economy with participants from think tanks and the business. live coverage at 8:30 eastern on c-span 2. >> they are going to say -- >> they decided on the indiana

case, it was constitutional for them to establish id. they did not say all of those states -- >> because of indiana. let me finish. you have misrepresented what i said. >> hold on. >> it is the lot of the land it. >> when i hear these accusations that voter id laws disproportionately affect minorities, it applies -- it implies to me we are lesser. if white at -- if white americans can get ids to vote, what are you telling black people? that somehow they are not good enough? they are less? that is what bothers me from a lot of the rhetoric coming from democrats and the left. we always have to make special

-- and there has to be a special mass when we deal with minorities because they are too feeble minded. we need to make concessions for them because they cannot follow the rules. when you treat people like victims, i do not think they want to aspire. >> more with crystal wright sunday night at 8:00 on c-span's "q &a." >> shaun donovan could not guarantee they would avoid using taxpayer dollars to shore up the home mortgage fund. this senate banking hearing comes after a report projecting a $16 billion deficit in the fha fund. this is one hour and a half.

>> i call this hearing to order. thank you for joining us, mr. secretary. i asked you to testify today because i'm deeply concerned about the recent report that the f.h.a. could potentially need taxpayer support for the first time in its 78-year history. i would like you to help the committee gain insight into the fiscal challenges at the f.h.a. and what h.u.d. has done and can do to mitigate losses and address the shortfall in the capital reserve ratio. f.h.a. has been helping save lives of the mortgage market by ensuring that qualified lower to moderate income and first time home buyers have access to credit since 1934. since the beginning of the financial crisis, the f.h.a. has

increased its market share from below 5% in 2006 to about 30% at its peak volume in 2009, in pursuant of that mission. this cyclical expansion was essential to the mortgage market, especially for first time home buyers who have comprised 78% of single family loans insured by f.h.a. in 2011. f.h.a.'s multifamily and health care insurance programs have also played an important cyclical role since the financial crisis with a fourfold increase in volume from 2008 to 2011. according to mark sandy, chief economist at moody's analytics, without the f.h.a.'s counter cyclical support, and i quote, the housing market would have

quit taking the economy with it. providing the backstop for mortgage credit when public services flee from the market has a cost. the losses at f.h.a. to stem from the new now prohibited down payment program, heavy losses in the first mortgage program, and losses -- loans made at the height of the crisis to prevent a collapse of the housing market. while they have already taken action to pretext the financial mortgage fund for single family loans from seeking federal funds, the f.y. 2012 report suggests that much more needs to be done to prevent such a draw. i want to hear more today about the administration's actions and proposals to minimize the risk to taxpayers stemming from

their business and what safeguards are in place to ensure the quality and sustainability of the program. if the administration's actions and proposals will not be sufficient to restore f.h.a.'s fiscal health, i'm inclined to work with my colleagues on both sides of the aisle on the banking committee to find a bipartisan way to make shoo -- that happen. before i turn to ranking member shelby, i want to recognize his work as ranking member on this committee over the past six years. this may be our last hearing together this year, and we will have no ranking member next year. i'm part of our bipartisan record over the last two years we continued it the tradition of bipartisanship that this

committee has been known for by passing signature bills together this congress. and i thank senator shelby for his service. with that i turn to ranking member shelby. >> thank you, mr. chairman. first of all i appreciate your remarks. i have been on this committee 26 years, ending it, but i'm not ending, i just have to move down a notch as i go over, hopefully, to be the ranking on appropriations. i won't be far away. i won't be far from secretary on h.u.d. stuff, either. but i enjoy working this committee. i enjoyed being chairman of this committee two congresses, the people on this committee are superb. the staffs are superb and this is a very important committee. not only for the senate, but for the american people and perhaps the world. as most people know, people are active on this committee because banking and housing and

everything that goes with it goes right to the heart of what ticks in america. job creation, availability of money, the regulation of our banks, the securities and exchange commission t. money laundering, sanctions on iran, you name it. most of it, this is an active committee, so i'll be around. right near here but i'll be yielding -- moving down one notch next to senator crapo, and will he do well. having said that, welcome again, mr. secretary. just days after the president's re-election, the f.h.a. released its 2012 actuarial report which revealed that the economic value of the f.h.a. fund has fallen to negative $16 billion. a lot of money. that means the fund's capital reserve ratio, as i understand it, now stands at a negative 1.44%.

this news is obviously very disturbing to us and to the secretary. for those of us who have long been concerned about the health of the f.h.a. for years the problems of the federal housing administration have been well-known. during the housing boom, the f.h.a. unwisely, i thought, guaranteed millions of risky mortgages with low down payments to borrowers with poor credit scores. we are reaping that now. these mortgages have resulted in billions of losses to the f.h.a. the federal housing administration has made matters worse, i think, by failing to come to grips with the magnitude, mr. secretary, of the problems. back in 2007, as the federal housing administration's poor financial position was becoming clear to all, including right here in this committee, i urged the f.h.a. to devise a credible plan to improve its finances.

i stated then and i'll quote, that before the taxpayers are faced with greater loss, i believe we must determine how the f.h.a. got into this position, mr. secretary, and how it intends to get out. unfortunately for the past five years the f.h.a.'s leadership has understated their problems and sought to kick the can down the road. this is now the fourth year in a row that the f.h.a. fund has been below its statutory minimum capital levels. yet each year we are told that this is a temporary dip and that within a few years everything will be fine. in fact, in 2009, mr. secretary, you told this committee that the drop in the capital ratio was expected to be, quote, temporary, and that it would, quote, return above 2% within the next two or three years, even if f.h.a. were to make no policy changes at all.

we now know this forecast is way off the mark. the administration, however, continued to be optimistic. in 2011, for example, h.u.d. still had its projection showing the f.h.a.'s capital ratio reaching 2% in 2014. now despite all these reassurances, the actuarial report projects that the f.h.a. fund has a capital reserve, as i mentioned earlier, of a negative 1.44%. what is the response of the f.h.a.'s leadership here? just this year after further declines in the f.h.a. fund, both secretary donovan and acting f.h.a. commissioner carol gallant, testified to two different senate committees that the fund would, quote, return to the congressionally mandated capital reserve ratio of 2% by 2015.

needless to say i'm not nearly as optimistic about the future of the f.h.a. i hope it works. i hope it does. the inability of f.h.a.'s leadership to clearly recognize and address its problems is raising doubts, mr. secretary, about the credibility and willingness to properly manage f.h.a.'s financing. i think it's time for f.h.a. to face facts. we have to. first, the capital reserve ratio, the federal housing administration fund, is dangerously low. you know that. and has shrunk nearly every year since 2006. f.h.a.'s statutory obligations every year since 2008. third, every year since then future growth in the capital ratio has underperformed in relation to f.h.a.'s predictions. hopefully the shock produced by these latest projections will finally be a wake-up call for

everyone. hard choices lie ahead for this program. we have talked about this. f.h.a. leadership, i believe, must fully realize its existing authority to shore up the value of this fund. additionally, congress must consider reductions in permissible risk layering and further underwriting reforms and re-examine -- re-examination of premium structures. it's time, i believe, to get serious reform of f.h.a. before it needs a taxpayer bailout, if it isn't too late already. i wish you well, mr. secretary, but you have a real challenge here. we do with you. thank you. >> thank you, senator shelby. are there any other members who wish to make a brief opening statement? >> thanks, mr. chairman. just briefly i want to agree with the comments of our ranking member, mr. shelby. and our general concern is that

we have seen this coming for a while. we have been talking about it. and the response from the administration has been very modest. unfortunately our worst fears are coming true, and even today i'm very concerned that the response even given this news is just way too modest. in discussing last year's actuarial report, the acting commissioner, carol gallante, said there is no evidence or widespread prediction that home prices are going to decline to the kind of levels that would require a bailout. yet right now the question is quickly becoming not if but when. and still even in the testimony -- secretary's testimony today, we are only talking about things like waiting until the second quarter of next year to raise premiums and then it by 10 basis points.

i really urge the secretary and others to consider other more aggressive, more proactive measures. mean "the washington post," which is not exactly a right wing think tank, said recently, quote, right now the critics are starting to look pretty prescient. affordable possession of one's own home is the american dream. government support excessive borrowing has turned into a national nightmare, close quote. and the focus of that editorial was, we still haven't fundamentally reformed that, including at f.h.a. so i hope we start getting on that track starting today. thank you, mr. chairman. >> senator menendez. >> thank you very much. i'll be brief. i look forward to hearing the secretary's response on how f.h.a. balances the goals of remaining self-sufficient

without taxpayer funds, but also helping what is still a fragile housing market in ensuring first-time home buyers can get credit. there is a clear case to be made in my mind that but for f.h.a. in the midst of this housing crisis, we would have a far greater crisis on our hands. and so reconciling the fiduciary responsibilities here to the taxpayers as well as the mission to people of america is incredibly important. i look forward to hearing that. and with your indulgence, mr. chairman, when it comes to my time in questions, while i certainly care about f.h.a., i have a even more pressing issue in the state of new jersey after thousands of homes were lost, lives were lost, and we are facing the greatest devastation the state has ever had. the secretary has been charged

by the president in that regard, to be the, i call it, czar, but whatever the appropriate title is, and i will have some questions in that regard on behalf of my state. thank you. >> thank you. i want to remind my colleagues that the record will be opened for the next seven days for opening statements and any other materials you would like to submit. now i would like to briefly introduced our witness, the honorable shaun donovan is the 15th secretary of housing and urban development. this is his ninth time before the full committee. secretary donovan, you may proceed with your testimony. >> mr. chairman. thank you, ranking member shelby, members of the committee, thank you for the opportunity to testify today regarding the status of the federal housing administration's mortgage insurance programs. i, too, want to add my thanks to ranking member shelby for his leadership and partnership on so many issues these last few years. this is an important moment for

our housing market and our nation's economic recovery. as 2012 draws to a close, there are encouraging signs. housing construction growing faster than any time since 2008. the strongest year of home sales since the economic crisis began. and rising home values lifting 1.3 million families above water in the first half of the year alone. f.h.a.'s programs have been a critical component of this recovery. that should come no surprise given the program's goals and history. with the dual mission of providing access for homeownership for underserved populations and critical financing for multifamily developments, nursing homes, assisted living properties, and hospitals, the f.h.a. is designed to fill gaps in the market, meet important commute needs, and act as a stabilizing force during economic distress. it's clear that f.h.a. has done just that. by ensuring much needed liquidity in the nation's mortgage finance markets, f.h.a. was a vital stabilizing force as we experienced the worst

economic decline since the great depression. in the last four years, the f.h.a.'s made homeownership possible for over 3.5 million families, including 2.8 million first-time buyers, and for 50% of all african-american and latino home buyers last year. while f.h.a. has acted as a critical support, it has not been immune to the stresses of falling home values and rising unemployment of the recession. according to the independent actuary's annual report on the m.m.i. fund, this fiscal year, the capital reserve ratio fell below zero to negative 1.44%, representing a value of negative $16.3 billion. we take and i take these findings extremely seriously. as stewards of taxpayer dollars, we have, since the start of this administration, made it a priority to strengthen the fund. and we are continuing to take aggressive action to return the fund to fiscal health, including those measures just announced in our annual report to congress. it's important for me to start by highlighting several key

points that put the actuary's report in perspective. fully $70 billion in claims are attributable just to the 2007 to 2009 books and business. these three years are the major source of stress to the fund. in fact, in its report, the actuary attests to the high quality and significant profitability of the books insured since 2010, the strongest in the agency's history. it's important to understand this report does not in and of itself mean it will be necessary for the f.h.a. to use its authority to draw from the treasury to cover projected losses. while this possibility obviously exists, it is dependent on several factors. first, that determination would be made using the assumptions bethe president's budget to released in february, not the assumptions used in the actuary's report. second, we expect that the new books of business generated after 2012 will create approximately $11 billion in economic value, further strengthening the m.m.i. fund.

third, since the actuarial report is a point in time snapshot, it does not take into account changes f.h.a. recently has announced to address the health of the fund. the final accounting of any shortfall would be done at the end of fiscal year 2013 in order to determine whether funds from the treasury are necessary. i'd also like to address the primary drivers of the decline in the capital reserve ratio as compared to last year's projections. first, the house price appreciation estimates used by the actuary for this review were significantly lower than those used last year. that may seem counter intuitive given the economic progress we have seen, but the actual turn around in the market occurred later than was projected in last year's forecast. in addition, for technical reasons, the forecast is also somewhat artificially dampened by the significant increase in refinancing activity in the market this year. second, the continued decline in interest rates while good for the overall economy impacts the actuary's model by

indicating marginally higher results. third, based on recommendations made by the g.a.o. and h.u.d.'s i.g., and at the direction of f.h.a., in this year's report the actuary changed the way it reflects losses from defaulted loans and reverse mortgages in the economic value of the m.m.i. fund. let me be clear, these are all important factors to consider when explaining the current status of the fund, but they do not minimize the seriousness of this report in any way. as i said at the outset, we have already taken significant actions to protect and strengthen the fund, including premium increases and changes to credit policy, such as increasing down payments for lower credit score borrowers, and ending seller financed down payment assistance. with your help, our efforts have added well over $32 billion to the fund. the measures i will outline today further address the primary source of the problem. losses stemming from legacy books and business,

particularly those insured during the 2007 to 2009 period and are designed to reduce our loss severities by at least 5%, generating approximately $3 billion in economic value over the next two years. first, we have announced changes to our loss mitigation program that targets deeper levels of relief for struggling borrowers to more effectively assist families in meeting their obligations and avoid costly foreclosures for f.h.a. similarly we are streamlining the use of short sales and aligning our practices recently announced to provide more families the opportunity to avoid foreclosure while reducing costs for the f.h.a. we have dramatically increased the use of alternative dispositions for defaulted loans, including our new distressed asset stabilization program. the improvement in recoveries from f.h.a. to this program is estimated over $1 billion this year alone. we are also taking proactive measures on new loans. in particular we are reversing a policy change made over a decade ago that allowed borrowers to stop paying

premiums after their loans reached a certain loan to value ratio. this change left the f.h.a. without premiums to cover the losses on loans held beyond the period for which those premiums were collected. reversing the policy is expected to improve the value of the fund by $2.6 billion in this fiscal year alone. in addition, we'll raise our annual mortgage insurance premiums by 10 basis points. we estimate this will increase cost to new borrowers by about $13 per month, but it will also further reduce our footprint in the market while adding an estimated $1 billion of additional economic value to the fund this year. as private capital returns, f.h.a. must continue to balance pricing to ensure it occupies a smaller, healthier share of the market. in fact, f.h.a.'s market share has been declining since 2009 and 2012 represents our lowest volume year since the start of the economic crisis. while i focus today on f.h.a.'s single family programs, i wanted to take the opportunity to reassure the committee our efforts to protect our

insurance funds span the range of our programs. we have already raised our mortgage insurance premiums on multifamily and health care loans, and instituted other risk management reforms such as special reviews for large loans, post commitment reviews by credit risk officers, and enacted loan -- an active loan committee process. even as we use our existing authority to take these measures to protect the fund, other actions require your partnership. in addition to the increased indemnification authority and broader geographical enforcement powers recently passed by the house, we have a number of proposals designed to place f.h.a. in a stronger fiscal position over the next 12 months and beyond. including new loss mitigation authority, additional enforcement authority, and greater administrative flexibility in managing the reverse mortgage program. house has recently passed important bipartisan f.h.a. reform legislation and we look forward to continuing to work with both chambers to create the tools we need to strengthen the program, meet its mission, and place the m.m.i. fund back on firm footing. i encourage the senate to engage in discussions that build

on this progress in the house in order to achieve a consensus that will give f.h.a. these tools as quickly as possible. there are no guarantees that the actions i have described will prevent f.h.a. from tapping into the treasury next september. however, swift action from congress, coupled with the $11 billion in additional value from the new fiscal year 2013 business, will reduce the likelihood that a treasury draw will be necessary. furthermore, these changes, as well as those we made over the past four years, have laid the foundation for a stronger f.h.a. and a healthier m.m.i. fund that supports the recovery of the housing market and economy, while actively reducing f.h.a.'s market share. as we work together to adapt and reform the f.h.a. program, we must proceed with a balanced approach that recognizes both the challenges to f.h.a. and its contributions to our economy. we are eager to work with you to achieve these shared goals. thank you again for the opportunity to testify today.

i look forward to taking your questions. >> thank you for your testimony. as we begin questions, i will ask the clerk to put five minutes on the clock for each member. secretary donovan, i'm very concerned about the f.h.a.'s fiscal condition as detailed by the f.y. 2012 report, particularly the negative capital reserve ratio. what action have you taken to restore f.h.a.'s capital reserve and prevent f.h.a. from requesting taxpayer support? >> mr. chairman, the most important actions that we have taken have been in partnership with this committee, and i would particularly recognize the fact that you passed a ban on seller funded down payments, which went into effect and we implemented in 2009. that action alone, we believe,

has saved the f.h.a. fund about $12 billion. there are additional actions that we have taken. we have raised premiums four times. made underwriting changes that include raising down payments for the riskiest borrowers. that series of changes has added, we estimate, an additional $20 billion to the value of the fund. quite simply, if we had not taken those actions in partnership with you, we would find ourselves in a vastly worse position today for the f.h.a. fund. >> mr. secretary, you have detailed several steps that would help stabilize f.h.a.'s finances. given the condition of the f.h.a.'s old books of business, why weren't these changes made earlier? will these changes allow the f.h.a. to outperform projections again this year and avoid drawing funds from the treasury?

>> as i said in my testimony, i cannot guarantee that we won't need to draw at the end of the fiscal year. what i can say is that i believe we are taking all appropriate steps to try to avoid that. balancing both the health of the fund but also the fragile recovery that we have in the market. for example, we have already moved to increase premiums for the fifth time. we believe that that is an appropriate step and that it leaves f.h.a. appropriately priced. we would be concerned, however, about going significantly further in raising premiums, both because it would have potential negative impacts on the housing market. we are seeing a recovery, but it is still fragile, and we do not want to hurt the market and in

turn hurt the f.h.a. fund by going too far to stop that recovery. but i would also suggest, as you see in the chart, on the right, we are currently, and the independent actuary confirms this, that the new books of business are highly profitable. and so i think there is beyond the market question a question of how far do we go in visiting the sins of the past on new borrowers? the premiums being paid by new borrowers more than cover the expected losses. appropriatelys priced and will help to shrink our market share, but what we need to do is continue to focus on these older books of business and that's why i focused in the changes that we have made we announced in our report to congress on steps that will increase our collections from these older books of business. just from the asset sales that we have instituted and were

going to ramp up going forward, we have increased the returns on these distressed loans by mortgage than 10%. simply with those steps. so we need to continue to focus on things and we have asked for authority from you to take steps that would help increase our returns on the older books of business. we think those are the most appropriate measures we can take. >> secretary donovan, one of these steps is better loss bit migation by transferring insurancing from servicers who are underperforming. what is preventing f.h.a. from doing that under its existing servicing contracts? >> quite simply we need legislative authority to be able to force those transfers to happen. that is a critical step. it is something that we have seen in the private market start to increasingly happen. it's something we believe would be very helpful to send a very

strong message to those servicers that are underperforming. but it is one of a number of steps that we would ask that you give us legislative authority for as quickly as possible. >> one more question. secretary donovan, the actuarial report finding of the negative in the m.m.i. fund is mainly problem legacy loans guaranteed during the housing bubble. what steps has f.h.a. taken to improve its underwriting criteria and risk assessments for the new loans? >> as i mentioned earlier, clearly the steps that you took to ban seller funded down payment loans were a critical piece of that. we also looked at the performance of our loans very

carefully. so in addition to the premium increases, we did require a 10% down payment for our riskiest borrowers. that we believe was a very important step in changing our underwriting. we also have taken many other steps on other aspects of underwriting that have to do with what costs can be rolled into the loan and other steps that reduce the effective risk of those loans that are quite important. part of that has been able to be done because, quite frankly, we didn't have a strong enough risk focus at f.h.a. in the midst of the crisis. we have created a very strong risk management focus through the creation of a chief risk officer for f.h.a.

that's never existed before. as well as building a team of analysts that are really providing data on an ongoing basis on early payment defaults and a whole range of other information that we simply didn't have before in real time. so it's not only the underwriting changes themselves. and also the focus on risk the way that we are measuring it on a real time basis that has given us new tools. >> senator shelby. >> thank you, mr. chairman. secretary donovan, lead me through this. tell me if i'm wrong on this or right or what. it's my understanding that under the statutes now prevailing that the federal housing administration could, if necessary, you deemed it necessary, tap the treasury for an endless supply of money. a lot of us would call that a bailout.

do you anticipate that? can you assure us and the american people today as the secretary of h.u.d. that f.h.a. will not do that? or you don't know yet? >> senator, i wish i could -- hi a crystal ball and coy tell you that we won't at the end of the year. given the actuarial report this year, obviously i'm highly concerned about that possibility. >> getting close? >> certainly we are closer than we have been in the past. >> how close are you? >> well -- >> honestly. >> what i will tell you, again, an independent actuarial report is the best can i give you in terms of that view. >> that's not good, is it? >> what it says -- >> the actuarial report is not good. >> it isn't. one important piece of this is that the -- what is required for the actuarial is a review as

if we stopped doing business on the date of the actuarial. the important thing that we can do and that we have done to try to avoid taking funds from the treasury at the end of the year is to look at the revenue we expect this year, that's about $11 billion, and to make changes to underwriting and other steps that would help avoid that. >> does that include up in the premium -- upping the premium a little? >> we have already moved to increase the premium an additional 10 basis points, an average of about $13 a month. >> how much money would that be projected? >> that would add about $1 billion just this year alone. and much more into the future. >> what is the size of your portfolio today, roughly? >> it is over $1 trillion when you combine -- >> $1 trillion worth of loans? >> when you combine all the various programs. >> how much -- how close are

you as far as working capital so to speak? >> it's an important question. today, even though the actuarial report shows a negative balance, we have a cash balance of over $30 billion today. $30.5 billion. one of the things the actuary looks at, assume we continue to do business, assume that we continue to operate, what is the likelihood, obviously we plan to continue to operate, what is the likelihood that we actually -- the cash balance goes negative? and the actuarial, despite the worst condition this year, still has a less than 5% chance that we actually run through all of those cash reserves. >> gives us the worst case scenario. it's the first week of december now. say three weeks, what's your worst case scenario, getting up to the first of the year, where you might be or not be?

what would cause you to -- cause to you have a lot of heartburn say around the first of the year? >> the single greatest issue of concern is where the housing market will go from here. if the housing market continues to recover as it has this year, that's the most important thing that we can see to restore the fund to health. house price appreciation is the single most important variable in the health of the fund going forward. it that is also why i will say we are so concerned about balancing the steps that we are taking to make sure we are not doing anything that would impede the recovery and come back and harm the f.h.a. in the long run by decreasing the improvement that we see in housing markets. >> we all realize that f.h.a. serves a good purpose, but it's just not sound financially.

as the secretary of h.u.d., shouldn't the fiscal well-being of f.h.a. be one of your highest priorities? >> absolutely. absolutely. >> you're just going to deal with what comes up like you outlined today? >> i would welcome additional ideas and suggestions that you may have. i certainly feel that we will take steps within our power. we would like to work with you, as i have said, as quickly as possible, to move additional authorities that would help us do this, but i am also opened today or any time to additional suggestions about what further steps we could take. >> if you do tap the treasury, in other words there's a bailout, so to speak, it's a sizable one, how would you pay that money back?

premiums? better efficiency? the housing recovery? all of the above? >> we certainly believe that we need to keep f.h.a. in a position where our new books of business are producing substantial revenue for the taxpayer. this year alone we expect our new loans to return a $10 billion profit, if i could use that term, to the taxpayer. that is the way that we need to continue to restore the health of the fund and should we need to draw on the treasury to restore that money to the taxpayer. >> thanks, mr. chairman. >> senator reed. >> thank you very much, mr. chairman. thank you, mr. secretary. i repeat what my colleagues have said. it's very disturbing to have a report that shows 1.4% negative equity at a critical fund. and this is an issue that has

not suddenly emerged. it's been brewing over several years. you have indicated that you are taking steps to fix these problems. and many people have said that in the past, too. again, can you sort of give us some assurance that this time is different? >> what i can say, senator, is that i believe we are taking every responsible measure that we can to improve the health of the fund. while at the same time not hurting the fragile recovery that we have. i do not have a crystal ball and i believe that we need to continue to take input and guidance on getting a better picture of the fund. one of the reasons why the fund looks significantly worse this

year than it did last year, we got criticism last year from outside experts, from the g.a.o., from our i.g. of the way that we model claims in our actuarial. we went back and directed our actuary to change the way we model, and that alone, that change alone, subtracted $13 billion from the value of the fund. i'm not going to sit here and say we have been perfect in the way we looked at the fund or we have modeled it. one of my responsibilities is continue to make changes to get as accurate a picture as we possibly can and to take steps based on that. >> let me ask perhaps a related question, as you look forward in terms of the health of the fund, one fact would seem to me, i would assume it would be explicitly in the model, would be assuming about employment

rates going forward. what unemployment rate are you assuming over the next year or so? because it directly affected payment -- >> absolutely. one of the important changes we made to the model this year not to get too wonky here, is to go to something called sacastic modeling. we chose one path and modeled based on that. state of the art modeling, assigns probabilities to a whole different range of paths the economy might go through. we actually modeled a vast range of scenarios. one of the things we looked at last year that we directed our actuaries to look at last year was to say what if interest rates go low? what's going to happen to the fund? we ran that last year. that scenario predicted that the fund would go negative. in fact, we have had what is effectively the low interest rate scenario happen this year with qe-3.

that was clearly had a substantial impact, roughly a $10 billion negative impact on the fund just from those interest rates alone. those are clearly steps that we are taking. we would be happy to share with you the various unemployment rate scenarios that we are looking at and home price paths we are looking at, but again we look at a range of those to get to the best possible prediction. >> you got close to wonkiness with sacastic modeling. one of the problems that you face is this series of years of terribly mispriced loans in 2007, 2009. and it would seem to me one of the things that you are trying to do is to clear these as quickly as possible. but as you have indicated to us, you need help with servicing. that you have to do much more aggressive modification, sales,

and also for the real estate that effectively alone, you have to dispose of it. can you comment on how much you think you can achieve in relieving pressure on the fund by doing that? looking back and taking care of that period? >> we think with a set of changes that we are already taking, that we announced in our report to congress with the actuarial, that include the loan sales that we have taken, changes to short sales, changes to what we call our loss mitigation waterfall, how we work with borrowers that are in trouble, those alone could add about $3 billion to the fund over the next couple years. what we need help on is that many of our enforcement authorities, and again if you think about how we collect on the bad loans, enforcement is an important piece of that. to say to lenders, you made a bad loan, there was fraud or something else involved, we need to hold you accountable for that and bring funding back to the taxpayer.

there are a number of provision that is would help us. one is giving us broader geographic authority. we have some perverse restrictions right now in legislation in terms of the way that we can hold lenders accountable on a narrow geographic basis. what we can do to require indemnification of loans, the standard for fraud, those are all pieces of what we would want to work with you to get past very quickly -- passed very quickly to enhance our enforcement authority. those as well would likely add billions of dollars to the fund. as you know we have been able to recovery well over $1 billion just this year in settlements around servicing and originations with many of our biggest lenders. >> thank you very much, mr.secretary. thank you, mr. chairman. thank you for your testimony today. you asked for some suggestions and i'd like to make just a few. it's my understanding that on

the private side right now fico score is really at 620, where the market is. and f.h.a. is at 580 and basically it's creating a situation where the private lenders are being made out to be bad guys because even though your fico scores are 580, they are not doing anything before -- below 620. as one of the steps that you might take, would it make sense for you to go ahead and get on up to 620? right now there's huge demand out there, and at some point that's going to diminish and will drive back down as people try to get market share again. would it not make sense to go ahead and implement what the market is telling you to do? >> that is something that we are actually looking at.

i think it's likely that we take additional steps as we are working towards the president's budget and understanding in more detail the results of the actuarial. that is clearly something we are looking at. we are concerned that some of the overlays that lenders are putting on go farther than are necessary. in other words, we do believe that there's been an over direction, if you will, in some parts of the market, where we have what are very safe borrowers that are having a hard time accessing credit. but i also agree that we need to be looking at and perhaps adjusting on the fico side as well. >> generally for what it's worth, i appreciate your testimony today. i know we have had discussions about that sometimes in the past. and i do realize you had a lot of bad loans on the books that you inherited. i do think there are things you can do now to really cause the fund to be more -- far more sound. i do think you all are being slow in moving that way. a second one i would move to is reverse mortgages.

you are losing your shirt on reverse mortgages. losing your shirt. it's a small part of what you're doing, and yet you've got mortgage brokers out there that are making an absolute fortune right now, a fortune. some of them are good operators. a lot of them are sloppy operators. i don't understand why you don't shut the program down for 24 months as i know has been suggested to you? why don't you do that? >> once again, senator, you have hit on an issue that is an important one and that we do believe we need to make changes. >> why don't you just do it? >> frankly, we did make changes. we introduced a much safer, better, we thought, alternative through our safer -- saver program. we could effectively do what you said, which is to just create a moratorium on the other program. what we are concerned about is particularly given the economic crisis that seniors have gone

through, that we would be eliminating an option that works for some seniors, if it's done safely, in order to eliminate also the bad loans being made. our preference, if we could get authority from you to change the structure of the program to make it much more effective and safe, that would be a better way to go. if we can't get that authority quickly, we'll have -- >> i would think -- why can't we do a unanimous consent, it seems to me most people would be willing to do that? >> let's talk about that today. i would love to -- >> i know you've got a partial situation that has been very healthy. it seems to me if you're worried about seniors, you could keep the ability to draw down a partial amount which is very safe, and you would eliminate -- you could do that all by yourself. and we could worry about the legislation whenever it's time. i'm willing to look at it now. just for what it's worth it does

feel like there's a lot you could do to make f.h.a. healthy today that is not being done. let's talk further, ok. loan limits. seems like right now, fannie and freddie are down at 625. are you still up at 729. wouldn't it make sense to go ahead now and make some changes that need to be made? you can do that yourself. why don't we do that? >> as i think you know, we supported our loan limits coming down. and they were supposed to expire last year. congress made the decision to allow -- lower the g.s.e.'s loan limits but kept f.h.a.'s -- >> can you self-implement that? you cannot do that? >> i do not believe that given that congress explicitly extended those higher limits, that we can take that step. >> would you like for us to help you do that? >> we have supported before and i will state again today that

going back to the limits makes real sense. i will go further than that, that we should lay out a path to go back to even lower limits that existed before the crisis in a way that is done consistent with how we do housing finance reform. that is a larger question. but the immediate step of going back to the pre-era limits is one we would support. >> are you developing a fan. and i hope we could look at some of those things. home mortgage insurance. the way i understand that it works is private mortgage insurers when you get down to a certain loan to value ratio, the insurance -- the premium is dropped, but also the insurance is dropped. and yet you have a trillion dollars in loans on your books where the loan to value has dropped. they are no longer paying premiums, but you are keeping the guarantee in place.

that doesn't make any sense to me. and why don't you continue to make the homeowner, who has that guarantee, continue to make the premium payments? that would be something that seems to me would be extremely helpful to you during this difficult time. >> once again, an excellent suggestion. we announced with our report to congress that we were -- we are doing that for new loans. >> why not the ones on the books? >> unfortunately we can't go back and modify a contract. when that homeowner took that loan, they signed a deal with f.h.a. that said this is the way the premium structure would work. we looked at this. we fully analyzed it. we can't break those contracts, unfortunately. and so it's something that we are going to need to implement. i will say, however, that the value of doing it now in a low interest rate environment is substantially larger on these new loans for two reasons.

the lower the interest rate, the faster the amortization of the principal and therefore this will be a more valuable change. second because these loans are so low interest rate, they will be on our books far larger. frankly, not many loans in the past have hit that limit. so even though it's $1 trillion portfolio, the value of that change is quite small for the old loans. it's really going to be quite valuable for these newer very low interest rate loans. >> i'll be briefly two more questions. i see that f.h.a. is now making loans to people who three years ago were foreclosed upon. and that's a very different standard than even exists at fannie and freddie. i don't understand. why are you doing that? >> this is another area where we are working on changes. here's the issue.

we have a significant number of homeowners that were responsible homeowners, had good credit scores that lost their jobs in the biggest economic crisis this country has faced since the depression. and we believe if somebody can show that they are back at the work and responsible borrower again, that that's somebody that we ought to work with. i would agree that our standards are not clear enough in dividing those. so what we believe we need to do is clarify those standards but not necessarily eliminate the possibility that somebody who has done the right thing and through no fault of their own lost a job but can be a responsible homeowner again, has the chance. my view would be it's not just the three-year limit that's important, it's what are the criteria that we set for how somebody re-establishes their credit and being a responsible homeowner? >> my last question, thank you for your patience. first of all it sounds like there is a lot of things -- there are a lot of things that could be done right now to solve a lot of problems.

and i hope that we as a committee will figure out a way to work with you on those things. we need to work with you. but you can do the things you can do now. you and i had a pretty long conversation several months ago when carol gallante had the opportunity, candidly, to assume her post on a permanent basis. and we could not get the administration to agree to not airdrop something and bypass the committee. it's an unfortunate circumstance. but i guess as i look at it, i would just ask you the question, did we dodge a bullet in appointing her full-time with all the issues that we have at f.h.a.? and does she really have the ability to press the administration to overcome political issues to actually cause the fund itself to be actuarially sound? because it appears to me that we are still not quite doing the things we ought to do to make the fund operate.

it seems to me maybe there's a little political pressure and maybe she's not strong enough to make that happen. >> here are the facts as i see country. police we have taken the most aggressive steps in the history of people agency to make sure the business we are doing is strong. if you look at that chart right there, you will see a huge profitability relative to the history for the new loans we are making. we have only so much that we can do to fix the problems of those older loans. i agree with you on many of the steps you have described today. what we should not imagine is that somehow taking those steps can take us from the difficult financial condition we find them in today, somehow to eliminating what has been an

enormous trauma in the housing market. i have enormous confidence that carol can and will lead us on the path we should take. the evidence of the changes we have made, the steps we took, you remember last year, the president's budget thought we might need it last year. instead of a negative balance, we ended the year with a positive balance. those were aggressive steps that she took. i listened to her, and i believe that is the kind of leadership to help us continue down this path. >> thank you. senator? >> thank you.

thank you for your testimony today mr. secretary. i know the senator asked about reverse mortgages. i am concerned about that issue. i am particularly concerned that $2.80 billion of the $16 billion economic shortfall are related. can you talk a little more about why these losses are so severe? >> here is the fundamental problem, without getting into too much detail. the loans were generally variable rate and allowed the borrower. there is basically no option for them to do anything but draw the full amount.

>> why? >> we do not have the statutory authority to be able to make the changes to the program to allow us to limit the draw up front. that is the change we are asking to be made. our alternative, and i was just discussing this, we could basically eliminate or put a moratorium on our regular program, which is somewhat safer. the problem is we do not have that authority under that program to avoid the full-draw feature of it. the right answer is to give us the authority to make the changes we need so we end up with a safer product and frankly, a safer and better product for seniors. what we are finding is too many seniors and up in a situation where they cannot cover their taxes and we lead to a situation

where they have more leverage, more debt, than their home is worth by the time they are ready to sell at home. >> because of that change, that is what resulted in the huge, $2.90 billion? >> for most of the new loans we are making, they are at this full-draw, and there will be enormous losses going forward because of that feature. >> ok. also, the last time you testified before the committee, we discussed the national mortgage sediment. can you talk briefly about the fund, how it has benefited from the settlement? >> in the most direct way, it has benefited by well over $1 billion that came directly to the fund from that settlement. or that series of settlements.

also important, though, is we put in place, not just for fha loans, but for every kind of loans that were part of it, new standards for how they foreclose on loans, how they work with troubled borrowers, and those changes will have very important effects in the long run, because we will have fewer foreclosures and better recovery on the loans, whether it is through short sales were keeping the homeowners in their homes. >> the debt forgiveness for the bar worse, what is taxable -- this is set to expire at the end of this year. what is the interplay and how would the exploration of that

division impact? >> it would be a cruel irony if homeowners have the ability to stay in their homes because of a principal reduction that is both good for them and their lender because it will lower the losses on that loan in the long term, only to get, come tax time, a giant tax bill for that principle reduction, which drives them back into delinquency and potentially for closure. the president has made it a real priority to try to get that provision into whatever tax extenders' we may do at the end of this year and it is a very high-priority for us.

>> thank you. >> senator? >> thank you. thank you, mr. secretary. as i said at the beginning, i have the real concern shared by a lot of committee members that the changes and reforms fha has made you are talking about today are not significant enough given rigid given the looming threat. those things could be true. they could be more than ever before but not enough. is it not right that under the federal credit reform act, it would allow the treasury to make necessary credit transfers to fha in order for them to

continue making payments automatically? >> that is correct. that is the way not only fha but other similar programs are designed. >> that is obviously a significant for the taxpayer. we all care about that. can you commit to us that you will keep us and the congress fully apprised of your moving projections with regard to that? >> i am committed to make sure that if we would take that step, you would be fully and notified. >> my question was more than that. keep us fully apprised of your current and updated projection. today and whenever that changes, and if that happens?

>> we do provide a monthly report to congress on the status of the fund. if there is additional information or different information that would be useful to you in that. we are very happy to work with you on that. >> what i am talking about, as of today, the bailout? what is your best projection? >> what i would say is our best projection would be contained in the president's budget. we are still working on the underlying economic assumptions that go into that. i do not have anything beyond what the actuary did that would be a different prediction. >> today, you have no best guess about that? >> i am not sure what you would suggest is a best guess. we expect $11 million of

revenue and the changes we believed would bring billions of dollars of revenue. >> based on all of that, do you expect a taxpayer bailout? if so, when? >> based on those steps, i believe we have significantly decreased the chance. i will not sign a probability at this point. we are still working on the other steps in the budget. i would be able to give you a number when we have completed the budget projections. >> i want to re-ask for your best information on that as it develops.

we do not have that today. i think you have some idea of some best guess. i would like that. with regard to changes that are

.

>> how would you deal with the new chinese military leader? >> yes, well, first of all, let me say that i think that the relationships in the last couple of years between us have been quite historic. they have increased, and they have endured what in the past might have made them be truncated, so they've endured diplomatic issues that, in the past, might have stopped them, and wee continued to have them.

as i've said before, i was invited to beijing twice. i've visited with my counterparts there. just yesterday in my headquarters, the deputy chief of the p.l.a. navy was in hawaii in my headquarters receiving briefings on the future activities that our navys will do together, looking and talking through the issues of the rim of the pacific exercise of which you mentioned that will happen in 2014. we have a growing ability to have a tie log at the military level that's frank and open, and we do that through consulted talks we do on a periodic basis, and then we build a calendar of events on areas we think will have the most opportunity to have success working together. we build that calendar of events, and so far, we're having a very good record on meeting those objectives and actually completing them. right now i believe there's, in this time frame, i don't know

exactly, but there's an exercise that we are doing in a bilateral way between the u.s. military and pay con and with the p.l.a. so, i just sent let the record show to my counterparts congratulating them on their promotions and hoping that we continue to have a good and open dialogue. because in the end, we have the responsibility, the p.l.a. and u.s. military have a responsibility to have a good dialogue and relationship. it's in the best interest of not only regional security in asia, but also global security. >> i'd like to follow up on missile defense and dig a little deeper if possible. how concerned are you about the potential loss of the use of s.d.s. has an asset in your region, and the fact that the missile defense program here in

the states hasn't produced the successful intercept since 2008. as a follow-on to that, can you go into what you think your vision should be for adapting the p.a.a. that's in europe into asia? leaders here have said they would like to do some sort of p.a.a. in asia. >> well, you ask a lot of questions in there. >> well, let me talk about the s.b.x. in general. it was built as a research platform. it wasn't designed to be in a long-term baltic missile ark terk tour t. still has benefit in research and development, but since it was built, my estimation is that the overall sophistication of the keanlts have grown and grown globally so that the need to have s.b.x. in that role has diminished over time because other capabilities are mature enough

to be able to not have to have it. as far as the ability for the interceptors to be productive, i think you have to look across all technologies that we pursue and recognize that the significant technological challenges that have been associated with that program and really, i think, in the time frame that we've had to develop these systems, i think we've -- the technological part of this defense has donna mazing things in that time frame to be able to produce the caments that are there now. and i'm confident they're going to produce the result you're asking about in the near future. as far as the overall, how you would put a p.a.a. in europe, i came from europe in my last position. and again, it goes back to a

discussion for me about europe versus the size and the immensity and vastness of this region, a region even the pacific region in the indopacific and trying to apply that exact model to a defense of this area, i think that would be a stretch for me. however, i think there are opportunities as we look at our alliances, as we look at our growing partnerships, as we look at multilateral organizations who are investing in ballistic missile defense capabilities of their own. if they are properly networked and properly put into an organizational construct where they can work together, you will, in effect, have a type of p.a.a. ark terk tour, and i think that will happen over time. it will require information sharing between countries who may have not done that before and may be a little

uncomfortable with it, but i think that as the security environment changes, that there will be good opportunities for that to occur and we will pursuing those. >> in europe, u nato as at least an organizing construct. you adopt have that in the pacific so. when you talk about networking and linking things together, what is your construct to do that? is the u.s. going to be a broker? >> well, you know, we have historically had a bilateral relationship strategy in this part of the world, and now we're seeing a need for more multilateral organizations, so inharnt in multilateralism are the discussions about these type of collective security type of initiatives that you might pursue using the technology that is you're able to buy and operate. so knowing there's a way ahead here. >> thanks, admiral. you mentioned burma a little bit earlier.

can you talk about where military relations are with burma and how you see that developing in the coming years. >> right. first, we're mill to mill in burma. we're in the follow on the state department and the zgs on where to go forward, so we will be supporting the state department on this. my opinion is that as the state department and the leadership of the congress really works through any issues that might have in the past prevented mill to mill, that there are areas in our mill-to-mill relationships that we can be productive in early on that will help a government and a military who are seeking reform to be able to do things with them that will help them understand and help them be more productive in that reform,

particular as it relates to how you build a military that's subservient to a civilian leadership. how do you build a military that values rule of law, that values human rights, and can calculate that into an organizational construct and training? we can add value in those areas, and we're prepared to do that. >> we have time for two more, justin and christina. >> justin official from fox news. i want to ask you about your strategic shift. are you concerned that this shift could be considered premature considering there are still real problems in the middle east if you look at syria, where the u.s. is at r.f.k. for being drawn into a serious conflict there with weapons? there's obviously real concerns about iran as well.

is the shift occurring before the job is done in the middle east? >> well, i would go back to the president's strategy on this and take a look at it. did not say that we would shift everything we have in the military or in across our government into the asia pacific. it prioritized the asia pacific, but it also talked about an enduring reerment for us to be present and in a security role in the middle east as well. worry talking about a near-term perspective on this. yes, the middle east has issues and has historically had issues that will require -- obviously u.s. leadership, but also will require a certain level of military security over time. and we will have to balance that, as we look at the size

and nature of our structure, and once we have the assets we have to be able to accomplish it, but i'm convinced that we can do both in the long run. i'm convinced we're on a good slope in the asia pacific that will allow us to realize that over the next number of years. >> thanks for coming to speak with us. according to news reports, u.s. officials have said several nations have moved into the region. can you talk about why we're sending ships to the region and also the number one concern with north korea's planned missile launch, whether it's that they're violating international regulations or whether we're worried that they can actually be logical enough to reach the u.s. what's the number one concern is with that, and why are we moving ships to the region? >> the moving the ships would be today, moving them today or in the long run? >> today, or in this week.

>> well, we move she wants around the region all the time. we actually have a fairly robust deployed naval force that's actually stationed in that part of the world, so we do move them around for exercises, move them around for contingencies, and in this case, it should seem logical we'll move them around, so we have a situational awareness that we have, and to the degree that those ships are capable of participating in ballistic missile defense, then we'll position them to be able to do that. we will go forward with that. a lot of this is about, number one, so we understand what's going on. i'd say second to that is we happened if they do violate the security council and lanche a missile, what is it about? where does it go? who does it threaten? where does the parts of it that don't go in -- that don't go --

where do they go, and what are the consequences of that? and eventually i think your question about, you know, what are our concerns as far as homeland defense, from my perspective at at paycom, i have to worry about reashoorg our allies, reassure we have that well done. i also have a homeland defense reerment for other states in that part of the world. but i also have a supporting role to ensure that homeland defense should at some point in time, there be a nation that decided to attack the homeland with a ballistic missile that i'm in position to be able to -- we'll be able to influence that in a way that we control the outcome of. >> what's the likely u.s.

response gven that north korea will do this in the next couple of weeks? >> well, i'll refer you to the state department or to o.s.d. on that. that's want my lane to see what that response would be. >> monitoring the situation very closely? >> very closely. >> thanks a lot. do you have any closing comments? >> only that i appreciate all of you taking the time to come and do this. the asia pacific is a very complex region, but i believe that if we work this right, that we can continue to provide -- to have a productive, generally safe, generally secure environment in the asia pacific that wee enjoyed for the last roughly about 50 or 60 years, that i think has given rise to a lot of economic growth, a lot of democratization, a lot of things that have been good for

a growing global economy and a growing humanity, growing humanity. i think we have the opportunity to do that, and my job is to ensure that's the direction we head. thank you. [captioning performed by national captioning institute] copy [captions copyright national cable satellite corp. 2012] >> the expiration is part of the so-called fiscal cliff. on this morning's "washington journal," we'll look at the expiring unemployment benefits. our first guest is josh boak of "the fiscal times," then we have a roundtable. "washington journal" is live every day on c-span at 7:00 a.m. eastern.

>> the supreme court will look at what was passed in 2008 by a majority of 6-3, i believe, and they're going to say that is precedent. >> and what is -- and indiana had a voter i.d. >> we talk about fact. they decided on the indiana case, it was constitutional for them to establish i.d. they did not say that all of those states -- >> correct. they talked about indiana. let me finish though, because you misrepresented what i said. >> no, you're misrepresenting -- >> hold on, hold on, hold on. >> this is the law of the land. >> and when i hear these accusations that black people, voter i.d. laws, you know, disproportionately affect minorities -- it implies to me that somehow we have something missing in our brain, we're lesser. to me, if white americans can get i.d.'s to vote and go through all the processes to follow the laws, what are you

telling black people? that somehow they're not good enough? they're lesser than? and that's what bothers me about a lot of the rhetoric coming from democrats and the left, that we always have to make special -- you know, there has to be a specialness when we deal with minorities because they're too feeble-minded. we really need to make concessions for them because they can't follow the rules like everyone else. and when you treat people like victims, then i don't think that they want to aspire. >> this is the editor and publisher of conservativeblackchick dodd, crystal wright, sunday night at 8:00 on c-span's "q&a." >> at a hearing on the so-called fiscal cliff, two economists agreed the problem will have to be resolved immediately to avoid pushing the country into recession, but they disagreed on how to raise the needed revenue. senator bob casey chairs this

joint economic committee hearing. it's an hour and 45 minutes. >> the committee will come to order. we want to thank everyone for being here today. i did not have a chance to personally greet our witnesses, but i will have time to do that later. i want to thank both of our witnesses for being here. i will have an opening statement that i will make, and then i will turn it to dr. burgess. i know that vice chairman brady will be her as well. we know the challenges that we confront here in congress on a whole range of issues, which are sometimes broadly described under the umbrella of the terminology, fiscal cliff. when we confront those difficult challenges, we have to ask ourselves a couple of

basic questions. one of the basic questions we must ask is, what will be the result and will be the impact as it relates to middle income families? what will happen to them in the midst of all these tough issues we have to work out? we know there is broad agreement that going over the so-called fiscal cliff would jeopardize the economic recovery. it would do that by increasing taxes on families, halting employment growth, driving unemployment up instead of down, triggering a deep cuts to programs that families across the country count on. the job before the united states congress is to reach an agreement that builds on the economic progress that we are making, and puts us on a path to fiscal stability. we need to cut more spending, and generate more revenue. we need to do it in a smart way that keeps our economy growing.

earlier this year, congress extended the payroll tax cut through 2012. the two percentage point payroll tax cut has played an important role to sustain the recovery. boosting economic growth by an estimated 0.5% of one percentage point, and creating 400,000 jobs. we should continue the payroll tax cut through 2013, and yesterday i introduce legislation that would keep the employee payroll tax at 4.2% next year. to keep the economy growing -- there is good evidence of that in the last couple of months? job growth of about 511,000. to keep that momentum going, we should provide tax credits to small businesses.

my legislation includes such an incentive for small businesses to grow. i am confident that congress will again be successful in reaching a compromise in the days ahead. i look forward to hearing today from the experts that we have before us today on how to reduce the deficit while protecting middle income families. as we enter the holiday season, americans should not have to face the uncertainty that many will face with regard to their taxes. there is no reason that middle income families should go into this holiday season without knowing whether their taxes will go up next year. last year, democrats and republicans work together to cut nearly $1 trillion of spending. now we need to continue that bi-partisan work to cut more spending, and to bring in additional revenues. if congress fails to reach an agreement under the budget control act of 2011, $1.2 trillion in automatic spending

cuts will take place between 2013 and 2021. republicans and democrats agree that indiscriminate across-the-board cuts is not the right and to do at this time in our nation's history. if we trigger the automatic spending cuts and tax increases, gross margin bottom will fall by half a percentage point. we will reverse the hard-fought gains over the past few years. we cannot afford to go backwards. instead we need a balanced and bipartisan approach. one that balances the short and long-term needs, distinguishes between foreign investments and the core investments that must be reserved, and spending that we can live without that utilizes both spending cuts and revenue increase.

the first order of business should be to protect those middle income families i talked about and protecting them from a tax increase. the cbo estimates that simply extending the middle-class tax cuts would boost gdp by 1.3% and create 1.6 million jobs. let me say that again -- boosted gdp by 1.3% and create 1.6 million jobs from that tax cut we can enact. it would resolve much of economic safety for these middle-class families. the wealthiest among us can help us reduce the debt by paying more. it is encouraging to see republican members of the house and the senate speak out on the need or a deficit approach that includes raising taxes on wealthy individuals and to

moving right away to ensure that 98% of families do not face a tax increase. we need to look at history. what we saw in the 1990s and 2000s, there was no relationship between lower marginal tax rates for the wealthiest among us an economic growth. first during the clinton administration, the top marginal tax rate was raised on the wealthiest individuals and the economy grew at its fastest rate in a generation. it added more than 22 million jobs. during the following eight years, the top marginal rate dax tax rate was lower, but economy never regained its strength from the reviews decade. middle-class families are vulnerable when the recession

began at the end of 2007. i hope this hearing is helpful not just in this hearing, but across this country to people who are watching and waiting for congress to act. i will say more at the end about some of our members who are leaving. it has been an honor for me to serve as chairman of this committee and also served with my friend, kevin brady, as vice chair. he has been great to work with. i hope there'll be bipartisan success in congress. i look forward to working with him as i change seats in the senate for the next congress. i am grateful to our witnesses, whom i will introduce. before i do that, opening statements. >> i think the chairman for the

recognition. this is the concluding hearing from the 112th congress. i'm behalf of the vice chair, kevin brady, on behalf of republican members and myself, we wish to thank you or your services on the committee. this unique committee with equally divided. people are used to seeing such division producing gridlock in washington, but senator casey and senator brady worked together and had bipartisan cooperation. joint economic committee has riced as a widely respected forum on debating issues. i think you, senator casey, for your leadership. i also want to recognize the retiring senator from this

committee, the senator from new mexico and the senator from virginia. our first secretary of the treasury, alexander hamilton, observe energy is a leading character in good government. the president must lead in a divided government and must not advocate his or her responsibility. president obama has the responsibility to propose a real bipartisan plan to avert the fiscal cliff that can pass both the house and the senate. withdrawing from the recommendations of the simpson-bowles commission, the president could propose a plan that would not only avert the so-called fiscal cliff, but also help us avert the fiscal abyss. if president obama were to offer such a plan, republicans would act favorably. going over

the cliff is unnecessary. as it has been observed in "the wall street journal," the president is boxing in the republicans. he is offering them a deal they cannot accept. first, the president has repeatedly called for a balanced solution involving both revenue and less spending. what is obvious to the most casual observer is that this plan is not a balanced. the fiscal cliff involves nearly four dollars of anticipated revenue from higher taxes for every dollar of spending cuts, yet the president wants more revenue and fewer spending cuts. if we fell off the cliff, his plan calls for another round of stimulus spending.

you have got to be kidding me. what the president's plan lacks is any reform in our entitlement system. the unrestrained growth in entitlement system is driving deficits and driving the debt even higher than the percentage of our gdp. it is estimated to be as high as $128 trillion. even if they confiscate all of the income that excesses $1 million, we cannot pay for the entitlement commitments that the federal government has made. we have made promises to ourselves that we simply cannot keep. without some sensible entitlement reform, our credit rating will be downgraded again. we will become a country that none of us recognize. secondly, fiscal plans failed to achieve their government

budget deficit or debt reduction goals. dr. hassett has examined fiscal plans in other countries. on average, unsuccessful plans proposed an increase in revenue and spending cuts. moreover, the higher revenues in successful plans were generally drawn from non-tax sources and avid sales and adjusted fees for government services. thirdly, the government argues that the 2001 tax cuts are extended, raising tax rates on the top 2% will not harm the economy because it will not affect consumption expenditures. however, analysts have analyzed the combination of expectation of the 2001 tax reduction for

the top 2% and the extension of the medicare act and capital income. under the president's preferred tax policy, the top rate would go from 35% to 49.9% and for ordinary income from 15% to 25%. the long-term consequences of president obama's tax policies would have a profound and negative affect. capital stock would fall. fewer jobs and lower wages resulting in higher taxes would harm the middle class. data reveals three important facts of high income earners. the taxes on the wealthy raise as much faster than on everyone else during economic booms, but they also fall much faster during economic bust.

people report more income when tax rates are low and not when they are high. there are better ways to increase federal revenues than hiking tax rates. congress could enact a program of tax reform that would lower rates and eliminate interest reductions. the president could open up more federal lands and offshore areas for energy exploration. his administration could take a more balanced approach to new regulations. economic growth can help solve our fiscal problems if the economy had grown at the percentage as it has done in

the past. the treasury could have collected an additional 650 billion dollars in fiscal year 2012. the deficit that would have fallen. still bad, but remarkably better than where we find ourselves today. republicans stand ready to work with president obama for a balanced and bipartisan solution. so far, no evidence of that. let's create a long-term solution that does not burden individuals and gives businesses optimism to go forward and invest in the american economy. then the economy can grow for all citizens. i look forward to the testimony of our witnesses. >> thank you. i will introduce our two witnesses. dr. zandi is the chief economist at moody's analytics. he looks at macro racquets and public policy.

he is the influential source of policymakers and businesses and journalists. recently he published a report assessing the challenges of approaching the fiscal cliff and the most effective way to achieve long-term, fiscal stability. he received his phd from the university of pennsylvania. that will be a recurring theme in these introductions. dr. zandi, thank you for being here. dr. hassett is the director and senior fellow at the american enterprise institute. he holds a phd from the university of pennsylvania. his research includes the u.s. economy, tax policy, and the stock market. he is previously a senior economist at the board of governors at the federal reserve system. he went to that graduate school

of business at columbia university. he has worked for both the george w. bush and clinton administrations. both of you went to the same university. i'm sure you can agree on everything today. dr. zandi first. >> thank you for the opportunity. it is an honor to be here with kevin, a good friend of mine. let me say that these are my own personal views. lawmakers have to resolve three issues -- first, the fiscal cliff. second, raising the treasury debt ceiling, which as you know is becoming an issue rarely soon.

third, achieving long-term fiscal sustainability. that is deficit reduction and tax increases and spending cuts that allow the gdp ratio to stabilize by the end of the decade. these three things need to be done now. in terms of the fiscal cliff, if policy is unchanged and we go over the cliff and there is still no change after that, the gdp in 2013 will 3.5 percentage points. subtract that and that is a severe recession. cbo and others are probably us are underestimating how severe that will be because confidence is very weak. it is unclear how the reserve would response to this. we need to scale back from the cliff. at the very minimum, the cliff

needs to be scaled back so it is only a hit to gdp at 1.5 percentage points at most. if you have more of a drive than that, it it becomes it. the economy will weaken. the budget deduction will deteriorate. we are seeing a fiscal drag in europe. i would argue that we should smooth into this drag even more. make policy changes so next year the gdp is half of this speed limit. that would be consistent with extending an emergency program and some form of tax holiday. in terms of the debt ceiling, that needs to be increased. it would be nice to extend it

at the next presidential election. it would be nicer to get rid of it altogether. it is anachronistic law that is a problem. it creates a great deal of uncertainty. as you can see, it can do a lot of damage to the economy. there are a lot of reasons why it is being considered to eliminate that ceiling. it should be carefully considered. at the very minimum, we should push this to the other side of the election. we do not want to address the debt ceiling on a regular basis. it is damaging confidence. on fiscal sustainability, we need deficit reduction in the next 10 years of about $3 trillion. to get there, a balanced approach would be $1.4 trillion in tax revenue. half of that would come through tax reform and the other half

through higher tax rates. $1.2 trillion in cuts to programs -- medicare and medicaid, social security, and other budget items -- that would leave you with approximately $400 billion in interest savings. at all of that together and you get $3 trillion. the spending cuts were implemented as part of the budget control act. if you add all of it up, if you go down the path i articulated, the spending cuts would be -- the revenue increases would be 2-1. i think it is very consistent in the spirit of simpson-bowles. it would be a good goal to achieve. it is doable from both an economic and a political perspective.

finally, you need to nail this down. uncertainty is killing us. it is hurting business investments. it has not affected laying off decisions yet, but it will. if we do not nail this down, investors will bail and the economy will struggle. but if you address this problem reasonably -- we have made a lot of progress since the great recession. if we nail this down, we will be off and running. thank you. >> dr. zandi, thank you. dr. hassett. >> thank you. it is always a pleasure to appear before this committee. under your leadership, this has always been a collegial lace to

testify. it is an honor to be here. my testimony is broken up into two parts. in the first part i described the short-term consequences of going off the fiscal cliff. in that section, i concur with dr. zandi that if we were to go off the fiscal cliff with no policy changes, then the near-term negative economic consequences would be significant. it would throw us into a recession. in the second part of my testimony, i will discuss the trade-offs we face between putting off the tough problems for tomorrow because we are worried about near-term effects. i think the evidence of the long-term effects of government debt to gdp ratio is quite overwhelming.

it began with an early analysis who analyze economic growth that high debt levels. it has been confirmed that high levels of government debt shows low economic growth. these literatures can get more sophisticated. there is a paper that identifies a tipping point in gross debt to gdp ratio. if it gets above 73% and we are above that now, that has a very significant and negative affect on economic growth. to put the result in perspective, there is a simple tabulation that provides intuition for the result. if you run a deficit of 6% in gdp for the next 10 years, that would add to the gdp ratio. that increase would be a not by the end of the decade that

would reduce the forecast. these effects are very significant. that growth story might be alarming, but the picture looks worse if you think of financial calamity. much of europe this year has been in turmoil because of the greek crisis. look at the struggles and other countries and take consolation in our relative stability. a recent study examined long-term projections for other countries debt burden. it found that the u.s. has a bigger adjustment than any of the european unions. it gives an urgency for us to act.

it is also possible to theorize about how a continuation of these policies could hurt growth farther into the future. a recent paper shows that if we do not act on this, and we are basically producing a fundamentally different america. it suggests that we are going to move into a world by 2040 were economic growth in the u.s. is not what we normally expect to see each year. there is crowding out of unity by the government. that is how urgent it is. what should we do? there is another large literature that looks at fiscal consolidations.

using my own study as an example and along with my two colleagues, our metric of success is that they achieve deficit reduction. we found fiscal consolidations that were very heavily weighted for spending were much more likely to be except the both then consolidations that were heavily weighted toward tax increases. we speculate that this is because we find this result because the tax heavy fiscal consolidations do not make tough choices on entitlements and because spending is more real when you lift the tax rates. it is easy to discuss reforms that could but u.s. and a positive trajectory. dr. zandi and i agree on the rough outline of what that would look like. the political challenge is a heavy one.

if you look forward to the america we are creating, that we all have to agree that the stakes could not be higher. thank you, mr. chairman. >> thank you, dr. hassett. i would like to start with a comment about something we are probably not talking enough about. even as we are wrestling with trying to debt a handle on the fiscal cliff, we cannot lose sight of their urgent priority of making sure we have job growth -- job creation, to say the least. many of the components you have outlined -- that both of you have -- it comprised of the broad description of the fiscal cliff whether it is the expiring tax cut provisions, the expiring tax cut extensions, and spending cuts as well. if you consider more, which of

those would you consider having the biggest bang for the buck in terms of economic impact of those that we are discussing here today? >> it is a given that we will extend the current tax rates for taxpayers that make less than $250,000 on an annual basis. that is absolutely necessary. when you consider the other things that are happening -- in terms of the bang for the buck, the emergency unemployment insurance program is very effective. it is small in the grand scheme of things. cbo is estimating it would

costs per calendar year about $33 million. but the economic opportunity for job growth compared to the unemployment rate would be measurably more than that. we are down to go to million people in the program. it is falling each year. i expected to fall even more than that in the next year. there are also limits to how much emergency you can collect. there has been some good work that has come out of the

reserve. it is a very significant positive. i think the payroll tax holiday has been very affective. it has very high bang for your buck. it gets spent. it is designed in a way that helps lower income households. you might want to consider scaling that back. you can go to go 1%. remember making work pay? that was a good middle ground. it is probably more affect it in the sense that it is designed to help more middle and low income households. that is a very effective program. >> dr. hassett, any comments on this question?

>> thank you for asking that question. i disagree with my distinguished friend on this topic. keynes himself talked about the kind of place where we are right now. if you get onto a cycle of dependence on measures, it could lead to a downward spiral as the national get -- that gets bigger because you try to stimulate things with shots -- one-time shots. i speculate that you might incur that the best possible thing we can do right now for unemployed americans is fix our big problems. it would help if american businesses had clarity on what the future would look like. the sight of relief rally from such a thing would be worth better than anything you could get.

>> i appreciated. i'm out of time, but i will come back to these issues in a moment. >> dr. hassett, an interesting opposition since you cannot ask questions. let me pose a question to you -- if the best thing that can be done is a long-term fix for our problems -- get out of this cycle that we are in -- would you agree with dr. hassett on that? >> i agree that we do not want to get into a cycle of dependency. we need to phase out the support -- the temporary support we have been running through the economy. in fact, that is what we have been doing.

go back to 2009. by 2011, the fiscal policy was neutral in respect to the economy. this year it will subtract from growth 8/10 of 1%. we have gone from fiscal stimulus to fiscal drag. we need to smooth into the fiscal drag. the government will be -- debating how much of a headwind it will be. we need to smooth into that drag. in the long run, we will be better off for it. >> is that a committee rule? >> it's not a rule. we will just keep it to a minimum. >> let me ask you for your response to his comment on the

cycle of dependency. >> i think it is quite possible that is where we are. >> can i interject here? it feels that way to me. it feels like we are in a cycle of dependency. we are dealing with the 2011 debt limit and the stimulus from 2009. it is the same thing with different labels. i am having difficulty seeing a way out of this cycle, but i interested in your observations. >> the way that i think about this -- at moody's they have been careful to put in this perspective into their analysis. think about the way of what happens when you change the way you are playing the game.

if you decide to spend a lot this year or mail checks to folks this year, that has a multiplier effect. you might get 2% gdp growth this year. but if you take that away, you are starting out with gdp growth 2% lower. the problem is that the keynesian policy really needs to look at all three acts. so you go up and you go down. the effects are equal and opposite. there is a third phase where you need to pay for it. it is in the negative. in the end, you will have to pay something. you see that in the long run cbo analysis of these policies. we are in the hangover phase. i can say that there is a way out and it is very

promising. we need to recognize that we are out of the emergency period. if we can fix the problems, we can get out of the hangover. >> the president is proposing the 47% spending cuts and 57% spending increase. why in the world would be even consider the president posted plan under the scenario that you described? >> the argument against our paper being a guide is that there are many small countries that may be have to be more aggressive about spending because people who lend them the money might head for the exit quicker. if you want to base our consolidation on the things that have succeeded in the

past, we would be at a certain percentage of spending. there is great comfort that it would be successful. there is argument that we might be able to handle having bigger revenue share of that. if we copy the successful ones, we should surely almost succeed. if we have a half-and-half approach -- look at our paper when it came out almost two years ago. we said that the uk consolidation would fail. it had too much revenue. as we are seeing now, millionaires and billionaires are heading for the exit. that is what we are going to see. >> thank you. mr. chairman, i yield back. >> i would like to congratulate the chairman on his election and the fine work he has done as chairman of this committee and to congratulate mr. brady on being selected as his chair of this committee and the next congress.

for our distinguished witnesses, they agreed that what we need to do is have a long-term solution. i would like to ask dr. zandi how we achieve that. we are several million dollars apart from the president's proposal. how would you close that gap? outline the president's proposal and speaker boehner's proposal. how can we get people employed and move our economy forward? >> i apologize. there will be a fair amount of numbers here. the president's tax revenue proposal amounts to about $1.6 trillion over a 10-year period.

that is from higher tax rates. roughly 600 billion are from some kind of tax reform. they are all reasonably good proposals. speaker boehner's proposal on revenue -- is roughly $800 billion in tax reform. we are about $800 billion apart on taxes. my view is that we should roughly split the difference. i would suggest $1.4 trillion in tax revenue. $700 billion would come through tax reform. we can discuss what that might look like. $700 billion would come from higher tax rates.

the president would scale back one trillion dollars. we can talk about that. on the spending side -- does 600,000 -- of course, this was distracting from the spending cuts that are already in law. of the $600 billion, $350 billion is medicare and medicaid. $250 billion is ag subsidies and other government programs. speaker boehner has come forward with some proposals. i'm not quite clear on how much the spending cuts he has proposed. the president's proposal is short. to get to where we need to go, that $3 trillion target and fiscal stability, we need $1.2 trillion in spending cuts.

that should be part of the process. we should do some things to reform social security. after the end of the day, it needs to be almost double of what he is proposing. if you sit down and do the arithmetic of spending cuts and look at medicare and medicaid, unless you're proposing a big and structural change in the program, which i do not think is on the table at the moment, it is difficult to get that cut. it is really tough. if you do a run rate of about $600 billion in cuts, that is ok. bottom line -- fiscal sustainability at the end of this 10-yeariz